September 2009: Get Real

Sign of the times

In today’s buyer’s market, it’s not uncommon for some sellers to be saddled with two monthly mortgage payments—one on the house they live in, and one on the house they’re trying to unload…a predicament few people can afford for long.

For these sellers, listing the latter as a rent-to-own is an attractive option. This type of transaction can benefit a certain type of buyer, too.

Similar to a car lease, a rent-to-own (or, what is known in real estate parlance as a lease-option or a lease-purchase; more about that in a minute) works like this: Interested buyers pay what are called rent premiums—an amount slightly higher than the usual rent, with a portion of that money going toward an eventual down payment. (For example, if the monthly rent premium is $1,300, $500 of that might go toward the down payment.) At the end of a set period—usually around three years—buyers have the option to buy the house, using their accrued rent premiums as a down payment. (In this case, that’s $18,000.)

Additionally, renters have to pay a one-time option fee, a set amount usually in the four digits—let’s say, $5,000—that is also used toward the down payment, bringing the total down payment to $23,000.

If, however, the buyer decides not to purchase, they forfeit the option fee and all the rent premiums to the seller…which translates to a tidy source of income for the seller in an otherwise dismal seller’s market.

So why aren’t there more rent-to-own listings in Charlottesville’s housing market? (A cursory search on the Charlottesville MLS pulled up only five such listings.) ReMax associate broker Charles A. McDonald says that precisely because it’s a buyer’s market, there is no reason for buyers to lock themselves into long-term commitments when there’s “so much other inventory to choose from.” For Sale signs abound.

In fact, McDonald says rent-to-own deals make sense primarily for a specific kind of buyer: those who have less-than-prefect credit scores and/or no money for a down payment.

A closer look at the ins and outs of such deals for both buyers and sellers:

• The purchase price is locked-in from the very beginning, so if at the end of three years, housing prices have skyrocketed, the seller still gets to pay the lower, agreed-upon price (same goes if prices collapse). Related to this, the seller is contractually prohibited from selling to another buyer should a better offer come along.

• Because buyers stand to forfeit their down payment should they decide not to buy, they should be fairly confident this is a house they want. But this works both ways: If the buyer discovers the house has serious problems (faulty foundation and wiring, asbestos, etc.), the lost fees pale in comparison to the exorbitant repair costs they could encounter as owners.

• Another hurdle for buyers: They cannot be late making payments or they lose their entire rent credit—the amount that goes toward the down payment—that month. If this becomes a habit, it could mean thousands of dollars lost per year. The flip side, of course, is easy money for sellers.

• Unlike normal renters, rent-to-owners are responsible for all repairs on a home even when they’re still technically renting it. Think of it as homeownership in training.

• Understand the terms: Most real estate professionals call rent-to-owns lease-options or sometimes lease-purchase deals. Even though the terms are sometimes used interchangeably, there is technically a difference. A lease-option means just that: The buyer has the option to the buy the house. A lease-purchase means they’re contractually obligated to…an easily missed but critical difference.

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